Wesern slump as bad as '74-75 -- a German forecast

ByDavid R. FrancisAugust 5, 1980

Kiel, West Germany
— The noncommunist industrial world has entered a recession. Moreover, say the economists at the Institute of World Economics at the University of Kiel, "There is an increasing danger that the current recession may prove to be as deep as in 1974-75."

That last recession was the worst since the Great Depression of the 1930s.

Some members of the staff here suspected in 1972 that a recession was coming soon. But the group was overruleD, and the institution was too optimistic in its official predictions.

"We were not strong enough monetarists," noted Alfred Boss, one of the team of 15 economists here that makes periodic forecasts of the status of the domestic German economy, and also of the economics of the noncommunist industrial nations as a whole.

Today, howeveR, this Kiel institutin is regarded as the most "monetarist" of the five prominent economic research institute in West Germany. It believes strongly that changes in the growth of the supplyof money (M1 -- currency in circulation plus demand deposits in the banks) is the best measure to follow in forecasting the future of the business cycle, or, for that matter, in conrolling the economy.

After reading recent money-supply figureS, the instititue says that the current recession "is mainly due to pronounced restrive policies in almost all countries, instituted in the light of the acceleration of inflation, which was as strong as in 1973."

It adds: "Monetary expansion decelerated as sharply was in 1973-74."

The institute sees some hope that business investment in plant and equipment willnot be hit as badly as during 1974-75. This is because in some countries wage increases were not so large, taking into account at least partly the deterioration in the terms of trade of oil-importing industrial countries as a result of the boost in the price of oil in the last year or so. In other words, these countries must deliver more goods and services abroad to obtain the same amount of oil. Their standard of living has been damaged. But relatively small wage increases make the adjustment to this change easier with less inflation.

Nonetheless, the institute figures that because of the lage of six to nine months or so between changes in monetary policy and its actual impact on economic growth, the depth of this recession is "more or less predetermine."

In addition, the institute maintsin that the current tough stance of economic policy in the major countries "is likely to prevail for some time because of the priority to fight inflation and the unwillingness to increase the government deficit. Furthermore, policymakers seem to have realized that it is not possible to achieve and to maintain a high level of employment by stimulating demand."

It used to be that economic policyakers in the United States, Britain, France , and elsewhere believed they could stimulate employment through easier monetary and fiscal and not kick up too much inflation. But they have found that such stimulative policies prompt so much extra inflation that another round of recession and high employment is needed to the rise of prices. The economy ends up worse than before.

So some economic policymakers figures they should be patient and let the economy recover at its own speed.

The Kiel Institute does not exclude the possibility that policymakers may resort to stimulative measures "when they are confronted with the depth of the recession and the drastic increase in unemployment."

It goes on: "However, even if there were massive expansionary measures in the first half of 1981, a recovery of production would not occur before late 1981."

Overall, the institute expects real gross national product of the noncommunist industrial countries to bottom out in late 1981 some 4 percent lower than the preceding peak earlier this year.

It forecasts that the recession will be most severe in the United States, the United Kingdom, and Italy. Inflation was the worst in these countries among the major industrial nations.

"The recession in the United States may even be deeper than in 1974-75," the insitute warns.

It sees a "less gloomy" outlook for Japan, West Germany, and France.

On the more positive side, the institute predicts that inflation "is likely to abate during this summer in most countries," and "rather quickly."

For the industrial countries on average, it expects consumer prices to rise about 8 percent in 1981, down from around 11.5 percent in 1980.

Unemployment will increase "substantially" in the second half of this year and in 1981, the institute reckons.

Recently, because of its strict monetarism and current pessimism, the Kiel Institute has come under criticism by other economists in Germany.

The German central bank, the Bundesbank, for instance, prefers to follow a measure called the "monetary base," which includes bank reserves. Two academic economist recently attacked the Kiel position in an article in Wirtschaftswoche (Economic Week), a prominent business magazine. They argued that th e Kiel economists do not take account of the "velocity" of money -- how fast it turns over -- and of international influences.

But Mr. Boss sounds pretty cocky. "The empirical evidence is on our side," he says, displaying the charts that show a close lagged relationship between M1 and the West German gross national product, minus exports plus imports (to remoe external influences).

Moreover, the Kiel Institute forecast for the German economy this year appears to be correct. It forecast 1.5 percent real growth in GNP, while the four other major research institutes predicted 2.5 percent. The Kiel predition implies a solid recession.

Apparently the German economy did drop at a sharp 4 to 6 percent annual rate in the second quarter, after growing strongly in the first quarter.

"This will be very hard evidence for our approach," says Mr. Boss.

If the institute proves accurate also in its world forecast, then the hope of Western policymakers that they would avoid repeating the synchronized recession of 1974- 75 in the industrial countries -- that any recessions in these nations would be staggered over different years -- will have been disappointed. The result will be less growth in international trade and more severe recessions than otherwise.